The appropriate valuation and analysis of manufacturing costs have been for years a key factor in a successful business management. Manufacturing costs are commonly calculated on the basis of average cost, standard cost, periodic cost, last-in-first-out (LIFO) cost, or first-in-first-out (FIFO) cost. These costing methods are implemented on computer systems. Companies choose the costing method that is best suited for their business requirements, or that is required by law. It is not unusual to find companies using one method for fiscal or legal purposes and another for internal management analysis.
It is a common business scenario in some organizations to transfer products, sub-assemblies, and components among different cost groups (e.g., one or more factories, or warehouses). The cost of the goods being transferred, as well as freight and/or special charges involved in the transfer process, often impacts the average cost of the item. This is particularly true when inventory valuation is determined by the absorption costing method. In absorption costing, variable costs and some of the fixed costs are assigned to each item in the inventory.
Some scenarios for transferring materials can be defined very simply, thus simplifying the calculation of absorption costs and/or the sequence for calculating these costs. For example, FIG. 1A shows a simple transfer of an item between two cost groups. In FIG. 1A, cost group 1 typically fabricates an item B using component A. However, item B may also be transferred between cost group 1 and cost group 2, which uses item B as a component of item C.
In the scenario of FIG. 1A, the cost of item B to cost group 2 is affected by the cost of item B in cost group 1. In the same way, the cost of item B to cost group 1 is affected by the cost elements of cost group 2, thus creating a recursive process for the calculation of item B.
Other scenarios are more complex depending on the volume of the organizations and the relationships between them, thus complicating the calculation of absorption costs. For example, inter-organization transfer of goods between cost groups (e.g., warehouses, manufacturing plants, etc.) makes determining a costing sequence difficult. This is especially true in situations where an item, transferred between two or more cost groups, occupies different levels in the costing sequence of the respective cost groups.
As shown in FIG. 1B, there are transfers between cost group 1 (120), cost group 2 (130), and cost group 3 (140) and the proper sequence (110) for processing the transfer of items is not readily apparent. In cost group 1, item A3 is a component of item A2 and is in the lowest level of the costing sequence for cost group 1. In other words, the cost of item A2 is dependent upon the cost of item A3 while the cost of item A3 is not dependent upon other sub-assemblies. Item A2, which is in the middle level of the costing sequence for cost group 1, is in turn a component of item A1 which is in the highest level of the costing sequence of cost group 1. Thus, the cost of item A1 is dependent upon the cost of item A2, and in turn, item A3. In transaction 111, item A2 (122) may be transferred between cost group 1 and cost group 3.
Similarly, while item A1 is a finished product (e.g., in the highest level of the costing sequence) of cost group 1 (120), after it is transferred to cost group 2 (130) in transaction 112, it is in the lowest level of the costing sequence of cost group 2. Items A1 (121) and B3 (133) are components of item B2 (132), which is in turn a component of item B1 (131).
In cost group 3 (140), items A2 (122), B1 (131) and B3 (133) are in the lowest level of the costing sequence of the cost group and are components of item C1 (141). The problem typically encountered with an arrangement as complex as that shown in FIG. 1B is in defining where to begin the costing sequence. In other words, it is not readily apparent which cost group initiates the costing sequence to the other cost groups because the items are transferred between cost groups. In one conventional method the lowest level components for each cost group are costed simultaneously. Thus, items A3 (123), A1 (121), B3 (133), and A2 (122) are costed at the same time. Additionally, all inter-organization transfers between cost groups (e.g., transactions 111, 112, 113, and 114) are costed simultaneously. Then, a “roll-up” of the costs was performed wherein the cost for each level in the costing sequence was calculated.
Obviously, this costing sequence can be inaccurate because the cost of some components is not accurately calculated. More specifically, while the costing of items without dependencies (e.g., item A3 123) could be accurately determined, for other items it is not apparent which cost group should initiate the costing of the item. This in turn affects the calculation of the inter-organization transfers. For example questions arise such as; should item A1 (121) should be costed as an end product of cost group 1 (120) or a transfer from cost group 2 (130)? Should all of the components at the lowest level of the costing sequence (e.g., A3 (123), A1 (121), B1 (131), B3 (133), and A2 (122) be costed first? If this were the sequence, how is the cost of item A1 (121) calculated for cost group 2 (130) since its cost depends, in part, on the cost of item A3 (121) in cost group 1 (120) in which it is not a component? Should the items in cost group 1 (120) be costed first and then cost the other cost groups sequentially? If this is the sequence, how does this affect the cost of item A2 (122) for cost group 1 (120) since its cost is affected by the cost of item A2 (122) in cost group 3?